Venture Capital Investors, Capital Markets, Valuation and Information: US, Europe and Asia

Journal of International Entrepreneurship 2, 305–326, 2004C© 2004 Kluwer Academic Publishers. Manufactured in The Netherlands.

Venture Capital Investors, Capital Markets,Valuation and Information: US, Europe and Asia

MIKE WRIGHTANDY LOCKETT [email protected] PRUTHICentre for Management Buy-out Research, Nottingham University Business School,Jubilee Campus, Nottingham NG8 1BB

SOPHIE MANIGART [email protected] Leuven Gent Management School and Ghent University, Belgium

HARRY SAPIENZA [email protected] School of Management 3-365, University of Minnesota, 321 19th Avenue, South,Minneapolis, MN 55455

PHILIPPE DESBRIERESUniversite de Bourgogne, Dijon

ULRICH HOMMELEuropean Business School, Frankfurt

Abstract. This paper uses a large multi-country sample of venture capital firms to compare the approachesto investee valuation and sources of information used by venture capital investors in English, French andGerman legal systems as well as geographical regions. Different legal systems are significantly associatedwith the valuation mechanism used. In particular, compared to English-based Common Law systems, VCfirms operating in a Germanic legal system are significantly more likely to use DCF based measures andsignificantly less likely to use PE comparators. This latter result is also the case for VC firms operating in aFrench legal system who are also significantly more likely to adopt historic cost valuation methods. VC firmsin Europe and Asia are significantly less likely than US VC firms to make use of liquidation value methodsbut significantly more likely to use PE comparators. European firms are significantly less likely to adopt DCFmethods compared to US VC firms. VC firms operating under a Germanic legal system are less likely toutilise information from the financial press but significantly more likely to use interviews with entrepreneurs.VC firms operating under a French legal system are more likely to utilise interviews with company personnelas well as sales and marketing information. VC firms in Europe and Asia are significantly more likely thanUS VC firms to use financial press. VC firms in Asia are significantly less likely to make use of interviewswith entrepreneurs or business plan data. VC firms in Europe are significantly more likely to utilise sales andmarketing information.

Keywords: venture capital, valuation, information, Europe, emerging markets

Introduction

International entrepreneurship is receiving growing attention (McDougall and Oviatt,2000). Much of this work has focused on the behavior of entrepreneurial firms in

306 WRIGHT ET AL.

terms of either their cross-border activities or comparisons between firms in differentcountries. A key influence on entrepreneurial firm behavior concerns their access toventure finance. To date research into international comparisons of the operation ofventure capital firms remains limited (Wright et al., 2002). Early studies examined thegeneral factors influencing the growth of different venture capital (Ooghe et al., 1991;Manigart, 1994) and related management buy-out markets (Wright et al., 1992). Otherearly studies considered the different broad strategy formulations adopted by venturecapital firms in the US and Europe (Roure et al., 1992).

More recently, there is increasing recognition of the impact of differences in institu-tional, legal and cultural environments on the conduct of financial markets in differentcountries (La Porta et al., 1997, 1998). These factors may also impact the specific de-velopment of venture capital markets (Black and Gilson, 1998; Jeng and Wells, 2000).This raises questions about the need to understand the operation of venture capitalistsin different countries. While there may be some degree of commonality of venture cap-italists’ functions across countries (Sapienza et al., 1996), differences in institutionalfactors concerning regulation, normative rules of behavior and culture (North, 1990;Scott, 1995) may affect business practices internationally (Bruton et al., 2004).

The increasing international spread of venture capital and private equity as firmsseek to invest outside their domestic markets (Allen and Song, 2002) brings these prob-lems into sharp focus. Anecdotal evidence suggests that venture capital firms enteringinternational markets may under-estimate differences both with their home market andbetween apparently similar countries (see e.g. Wright and Kitamura, 2003 in respectof private equity entrants into the Japanese buyout market). Appreciation of this het-erogeneity is important for both researchers and practitioners. Venture capital firmsseeking to enter different countries within a particular region may experience problemsin generating target returns if they fail to take adequate account of the different modusoperandi of individual markets. While there may be differences between countries, thesedifferences may be driven by broader institutional characteristics relating to the stateof development of the capital, the underlying legal regime (e.g. English versus Frenchversus Germanic origin legal regimes) or broader geographic factors (e.g. Europe; Asia)(Bruton et al., 2004). Ultimately, these factors may influence the financing of the globaldevelopment of entrepreneurship.

Key issues for venture capital firms’ returns concern the methods used to valueinvestments and the information used to arrive at valuations. Valuations are particularlysubjective in venture capital investments where the business typically has less of a trackrecord than an established publicly listed company. The valuation placed on a businessat the time of investment can have a dramatic effect on the ability of the venture capitalfirm to meet its target rate of return. These issues are crucial in domestic markets butmay assume greater significance in different capital market environments where thelevel and nature of information may be at some variance to the domestic market. Thereis little research comparing venture capitalists’ approaches to valuation and sources ofinformation in different institutional environments.

This paper provides an initial exploratory attempt to address gaps in previous re-search by examining the role of the capital market, valuation methods and information

VC INVESTORS, CAPITAL MARKETS, VALUATION AND INFORMATION 307

sources used in the process of deciding to make a venture capital investment in dif-fering institutional environments and venture capital market contexts. Specifically weaddress two research questions. RQ1: To what extent do valuation methods vary acrossinstitutional environments? RQ2: To what extent do information sources vary acrossinstitutional environments?

In addressing these questions, our focus is on the overall behavior of venture cap-ital firms operating within particular markets. We present evidence based on surveysconducted in nine different countries. These countries cover a range of different le-gal systems. We include countries from the English law based contexts that includelong-established venture capital markets (the US and UK), more recently developedventure capital markets (Hong Kong and Singapore) and a developing venture capi-tal market (India). Also we include a Germanic law (bank) based environment witha developing venture capital market (Germany), a French law-based (network) envi-ronment (France, Netherlands and Belgium). We examine differences between theseinstitutional and geographical contexts since we anticipate that influences in behaviorwill relate to the structural differences between these contexts.

The paper begins by outlining how venture capital markets differ in relation totheir structural and institutional differences. Next, we develop the argument that aventure capital firm’s behavior, in relation to valuation methods and sources of infor-mation used, will vary according to its institutional environment. The third sectionprovides an outline of the representative surveys of venture capital firms in the ninecountries in the study. This is followed by an analysis of the findings. In the final sec-tion, some conclusions are drawn and implications for researchers and practitionersdiscussed.

Structural and institutional differences

In this section we argue that venture capital markets throughout the world are hetero-geneous in terms of their structure and the different institutions upon which they arebased. In particular, there are structural differences in terms of their stage of devel-opment and allocation of funds across different investment stages. However, we arguethat it is the institutions that underpin these markets that have a greater influence onthe behavior of venture capital firms. We expand below.

Structural differences

There are notable differences between the venture capital markets examined here, par-ticularly with respect to their level of development and the relative importance ofdifferent investment stages. Table 1 shows some important characteristics of the ven-ture capital industries in each of the countries studied here. The data in the table referto the total investment by VC firms based in each country. The US market is by far thelargest market, followed by the UK, France and Germany. Hong Kong is of a similarsize to the combined Dutch and Belgian markets. The Indian market is the smallest.

308 WRIGHT ET AL.

Tabl

e1.

Ven

ture

capi

tali

nth

est

udy

coun

trie

s($

m).

US

UK

Hon

gK

ong

Sing

apor

eIn

dia

Ger

man

yF

ranc

eN

ethe

rlan

dsB

elgi

um

Inve

stm

ents

($m

)19

9954

,994

11,3

671,

735

1,06

038

43,

400

3,03

41,

841

725

2000

106,

391

12,0

482,

426

1,28

183

05,

133

5,71

12,

063

608

Port

folio

($m

)19

9913

4,50

027

,720

7,18

72,

830

802

8,50

012

,496

4,92

11,

933

2000

35,8

408,

919

3,62

71,

550

12,3

5917

,073

6,41

62,

326

CA

GR

1993

–200

0(%

)29

2427

4720

2022

15V

C/G

DP

in20

00(%

)1.

070.

861.

481.

390.

170.

230.

380.

480.

23C

AG

RV

C/G

DP

1993

–200

0(%

)24

2018

3817

1718

11St

age

(200

0)Se

ed/s

tart

-up

2212

2630

4935

2219

47E

xpan

sion

5834

3544

4245

3655

46B

uy-o

ut18

5330

124

1838

196

Oth

erla

te1

914

52

47

1

∗ US

stag

efig

ures

rela

teto

2001

.


At the beginning of the 1990s, the US market was highly developed. In Europe, theUK, Dutch, Belgian and French markets were more established at the beginning ofthe 1990s while the German market was less developed and remained so at the end ofthe decade. The venture capital markets in Hong Kong, and Singapore emerged onlyfrom the 1980s, with that in India being more recent still (Verma, 1997). The threeAsian markets displayed somewhat faster growth rates than in the European countries.However, there are notable differences within regions, especially with respect to thegreater growth of the Indian market in Asia. These figures are consistent with Allenand Song’s (2002) findings that venture capital in both Europe and Asia grew rapidlyin the 1990s.

The markets also vary considerably in relation to countries’ GDP in 2000. Theannual investments made by venture capital firms in the US in 2000 was 1.07% butthis is exceeded by Hong Kong and Singapore with 1.48 and 1.39%, respectively. TheEuropean venture capital markets amount to considerably smaller shares of GDP,especially in Germany at 0.23%. These differences between the European countriesand US, UK, Hong Kong and Singapore is in line with expectations given the reducedemphasis on capital markets in the former (La Porta et al., 1997; Black and Gilson,1998). The much newer Indian venture capital market amounts to only 0.17% of GDP.

Early and expansion stage investments dominate the US market in terms of amountsinvested (Table 1). Allen and Song (2002) in comparing Asian and European venturecapital markets find that in Asia there was more investment in early stage projectswhile in Europe there was more investment in late stage projects. However, there arenotable variations between countries even within these regions. As Table 1 indicates, inEurope early and expansion stage investments are important in Germany and Belgium.The UK and French market have stronger emphases on buyout stage investments thanthe other countries. Among the three Asian countries examined here, Hong Kong alsoreports a relatively high share for buyout stage investments while India has the highestearly stage share. Expansion-stage investments constitute the most popular area ofinvestment in Hong Kong and Singapore.

Institutional differences

Venture capitalists’ valuation approaches, and the information they use in making suchvaluations, may be influenced by their institutional environments. Institutional theoryidentifies the effects of norms, culture and regulations on behavior (Scott, 1995). Theexistence of behavioral norms would suggest a certain degree of commonality of behav-ior by venture capital firms between countries, while cultural and regulatory differenceswould suggest differences between countries. One of the key aspects of different regu-latory environments is the framework influencing the regulation of financial reporting.Differences in such frameworks have been identified as important in differentiating be-tween markets (Wright et al., 1992). In this paper we focus on a country’s legal systemas an important influence on the behavior of firms in a country’s venture capital market(Jeng and Wells, 2000; Bruton et al., 2004).

310 WRIGHT ET AL.

A key difference between different venture capital environments has been the legalsystem of the country (Allen and Song, 2002). The major legal systems of the world arederived from either English law, French Law or German law (LaPorta, 1997). La Portaet al. (1997) show that the legal protection for minority shareholders matters for the sizeand extent of the country’s capital markets. This finding is explained by the fact thata good legal environment protects potential financiers’ interests and hence increasestheir willingness to provide funds in exchange for equity. English-based common-lawcountries have the strongest legal protection of shareholders, while investor protectionis weaker in German civil-law countries, and still weaker in French civil-law countries.

The US, UK, Hong Kong, India and Singapore have been categorised as having thesame English-based common law legal origin (La Porta et al., 1997). However, evenwithin English-based systems there is considerable variety of development of stockmarkets, the US having greater ratios of external capital/GNP, IPOs/population, listedcompanies/population than is the case in India, with the corresponding figures for UK,Hong Kong and Singapore being even higher (La Porta et al., 1997, 1998). Black andGilson (1998) argue that a well-developed stock market, providing exit routes, is criticalto the existence of a vibrant venture capital market. Jeng and Wells (2000) note that thelevel of IPOs is especially important for later stage but not early stage venture capital.In the US, the developed nature of the main stock market and the introduction ofNASDAQ with less stringent requirements provide opportunities for the realizationof venture capital investments. Further, a developed takeover market provides furtherventure capital realization options. In contrast, the Indian stock market is relativelyunderdeveloped with little scope for expansion in a regime dominated by state-directedcredit.

Black and Gilson (1998) also note that stock markets elsewhere in Europe outside theUK are under-developed as are venture capital markets. With respect to the Europeanmarkets, studied here, all except the Netherlands have lower external capital/GDPratios than any of the English-common law-based markets. Secondary tier stock mar-kets have been introduced such as the Second Marche in France the Neuer Markt inGermany but with limited success.

Bruton et al. (2004) argue that the nature of a country’s legal environment and, relatedto this, the development of its capital markets, not only influences the development ofits venture capital industry, but also the behavior of its VC firms. Apart from theexistence of laws, the enforcement of those laws is an important issue for financialinvestors. Local cultures affect how different regulations are implemented (Kostova,1997). Legal enforcement is probably highest in the US, intermediary in Europe anderratic to non-existent in certain parts of Asia (Bruton et al., 2003). It is expected thatlaw enforcement will impact the way VC firms behave.

Besides regulatory institutions, particular countries may be characterised by differ-ent cognitive or cultural institutions (Scott, 1995) that may affect how VC firms behave.For example, the strength and importance of social and business networks may impactthe VC deal selection process (Bruton et al., 2004). Hence, we might expect that coun-tries with different legal systems are not necessarily homogeneous across geographicalcontexts.


In the following sections we develop propositions relating to the behavior of venturecapital firms across different institutional environments in terms of their valuationmethods and sources of information used in valuation.

Valuation and information in venture capital investment

Valuation approaches

A number of approaches to the valuation of enterprises are available. The limitations ofusing balance sheet based asset measures, especially historic cost asset values, to valueenterprises are well-recognised in standard finance texts. However, in the absence ofstrong capital markets, historic cost measures may be viewed as more tangible valuationmeasures. Shareholder protection is lower in French and German legal systems (LaPorta et al., 1998, 2000), making assets-in-place somewhat more important than inEnglish legal systems as a form of protection for investors. Further, Sapienza et al.(1996) also note that executives in Continental European venture capital firms are morefinancially oriented than US venture capital firm managers. In bank-based systems,many VC firms may be owned by banks, with VC executives having a background inbanking (Ooghe et al., 1991). Given the importance of collateral in bank lending, suchexecutives may be more likely to pay attention to the asset backing of investees. Hence:

P1a: Asset based valuation methods are likely to be significantly more importantin countries with French and German legal systems than countries with an Englishlegal system.

Where there is a high risk of failure, the expected liquidation value of assets may be animportant consideration in valuing potential investees. These valuations may be morefeasible in market-based systems, which tend to be associated with active takeovermarkets, especially for forced asset disposals (Shleifer and Vishny, 1992). The US hasnotably the most developed acquisitions market among the countries studied herewhile this is less true of Europe and Asia. Hence, although relatively little importanceis expected to be placed on asset based valuation methods in general:

P1b: Liquidation value asset based methods are likely to be significantly less impor-tant in countries in Europe and Asia than in the US.

Theoretically, discounted cash flow (DCF) valuation methods are superior to asset-based approaches. However, countries with less developed capital markets are lesslikely to utilise valuation techniques consistent with standard corporate finance theory(e.g. DCF, dividend yield) developed in an advanced capital market context. Hence, weexpect that DCF will be less important for VCs in countries with French or Germanlegal systems. Moreover, a lot of VCs are subsidiaries of banks in the bank-centeredGerman financial system. Former bank managers may not be trained to use prospective-looking valuation methods. Further, Hellman et al. (2004) have shown that bank-owned

312 WRIGHT ET AL.

VC firms pursue other goals than independent VC firms: cross-selling bank productsto their portfolio companies seems to be important for them. These features make usexpect that prospective-looking DCF methods will be less important for VCs operatingin French and German legal systems. Hence:

P1c: DCF based methods are likely to be significantly more important in countrieswith English legal systems than countries with French and German legal systems.

Capital markets may provide comparator valuations with publicly available informa-tion in terms of sector price/earnings ratios. This market-based valuation method isnot only relevant for valuation purposes at the time of investment, but it also providesan indication of potential values when going public. P/E and other comparator valu-ation methods are, however, only relevant when there are enough comparable quotedcompanies. Given that P/E ratios differ widely across different stock markets, it isimportant to have access to a wide range of quoted companies on the relevant stockmarket in order to be able to produce a meaningful P/E ratio. This is only feasiblein countries with well-developed stock markets, i.e. in English legal system countries(La Porta et al., 1997, 1998). P/E and other comparator valuation methods are lessinformative and valuable in countries with few public companies. Hence:

P1d: Price earnings comparator valuation methods are likely to be significantly lessimportant in countries with German and French legal systems than countries withan English legal system.

Sources of information

Unlike publicly listed corporations, venture capital investments are characterised byconsiderable private information (Wright and Robbie, 1998). The relative importanceof information from financial sources versus information from entrepreneurs and in-formation from alternative market sources may vary between countries according tothe relative importance of the capital market.

The US has developed a system focused on understanding entrepreneurs and theirpotential contribution to value creation, which may be especially important given theemphasis in that country on early stage investments. In network-based countries, greateremphasis may be placed on information relating to the entrepreneur than in a market-based system (Manigart et al., 2000; Bruton et al., 2004). Networks between businesspeople are generally seen as stronger in much of Europe compared to the US sincethe need to be part of a social network is viewed as vital (Wells and Grieco, 1993).Asia is generally recognised as having different cognitive institutions than the UnitedStates and Europe (Orru et al., 1997; Peng, 2000). Asian culture also emphasises theimportance of networks (Boisot and Child, 1996; Bruton et al., 1999); this may evenbe much stronger than in Europe (Tsang and Walls, 1998). Claessens et al. (2000) haveemphasised the importance of social and particularly family networks in East Asian


businesses. Bruton et al. (2002) note that in Singapore, for example, connections andrelationships with potential clients are likely to be far more important than in the West.In Singapore, applications from individuals who “walk in the door” are therefore lesslikely to receive funding than in the West. Network relationships are important forbank lending in Southeast Asian countries in the absence of more reliable alternativemechanisms (Rajan and Zingalis, 1998). As the venture capital industry is less regulatedand established than the banking industry in Asia, this suggests that relationships andother similar institutions could be even more important in this sector (Bruton et al.,2002). Allen and Song (2002) note that implicit relationships may provide a good sub-stitute for explicit contracts in environments of relatively low contractual enforcement,which may be more problematical in Asia. While members of a network may obtainreliable information (Fiet, 1995), venture capital firms face the potential problem ofbeing outsiders prior to a relationship being established. A common cultural problemin Hong Kong, for example, is the dominance of boards of directors by extended familymembers, which inhibits venture funds’ access to information and subsequent invest-ment decisions. As such, VC firms in Asia may be expected to place less credence oninformation about the business supplied by the entrepreneur. Hence:

P2a: Venture capital firms in German and French legal system countries are likelyto place significantly more emphasis on information provided by the entrepreneurthan are venture capital firms in countries with an English legal system.

P2b: Venture capital firms in Asian countries are likely to place significantly lessemphasis on information provided by the entrepreneur than are venture capitalfirms in the US.

The problems in trusting information provided by entrepreneurs may extend to infor-mation in the business plans prepared by entrepreneurs. In the US, for example, thereis some evidence that the business plans do provide useful financial information. In theUS, VCs have legal rights protecting their investment against agency problems relatingto the entrepreneur (Bruton et al., 2000). This may be more problematical in an environ-ment of weak legal systems and weaknesses in the enforcement of legal systems. Ownersmay be asked to give warranties regarding the veracity of information in countries inEurope and Asia. But it may be naıve simply to rely on warranties in environmentswhere the enforceability of contracts may be difficult and where recourse to the courtsmay have adverse implications for reputation (Ahlstrom and Bruton, 2004). In China,for example, reporting regulations may not be enforced such that reported fixed assetsand accounts receivable may be unreliable (Bruton and Ahlstrom, 2003). Accountingstandards in the French and German legal system countries studied here score onlyslightly less highly than those with an English system except for India (La Porta et al.,1997). In this context of relatively strong financial reporting systems, European venturecapital firms are likely to emphasise accounting and financial data equally highly astheir US colleagues. Hence:

314 WRIGHT ET AL.

P2c: Venture capital firms in Asia are likely to place significantly less emphasis onaccounting and financial data in the business plan as a source of information thanventure capital firms in the US.

Venture capital firms may seek to verify the situation in potential investees by placinggreater emphasis on other sources of information in an attempt to obtain indepen-dent information (Fried and Hisrich, 1994). Less market oriented systems may alsobe associated with a lower willingness to disclose non-mandatory information. Hence,the financial press in German and French legal system environments may provide lessuseful information for venture capital firms. The market risks in India, as measuredby the risks associated with undertaking contracts, are markedly higher than in HongKong or Singapore which are in turn higher than in the US (La Porta et al., 1998).Therefore, venture capital firms in Asia may rely more on independent verification suchas through financial press and trade journals. Hence:

P2d: Venture capital firms in German and French legal system environments arelikely to place significantly less emphasis on information from attempts at verificationfrom other sources than are venture capital firms in English legal systems.

P2e: Venture capital firms in Europe and Asia are likely to place significantly moreemphasis on information gained from attempts at verification from other sourcesthan are venture capital firms in the US.

Methodology

The questionnaire administered to respondents was developed based on a previousquestionnaires used in the UK which had been pre-tested with UK venture capitalists,advisors and academics (Wright and Robbie, 1996). An organization-wide responsewas sought in all cases, with the covering letter to senior investment managers specif-ically asking respondents to report institutions’ perceptions rather than individualapproaches; the UK study had suggested that the issues examined here were in anycase generally driven by organization-wide policies.

For the UK, the questionnaires were sent to the full members of the British Ven-ture Capital Association in early 1994. The questionnaires were translated into Frenchand Dutch, in order to be used in France, Belgium and the Netherlands. They weresent to the full members of the ‘Association Francaise des Investisseurs en CapitalRisque’, the Belgian Venturing Association, the ‘Nederlandse Vereniging voor Partici-patiemaatschapppijen’ and to the French, Dutch and Belgian members of the EuropeanVenture Capital Association in late 1995—early 1996 and to members of the GermanBVK in 2001. In total, we received 203 responses, giving a response rate for Europe of38.7%. The responses from these countries consist of a relatively larger number of inde-pendent venture capital firms compared to the VC industry in the respective countries.The stage distribution of the investments in the sample under study is, moreover, moreheavily weighted towards acquisition/buy-out investments, compared to population


statistics. The fact that the venture capital firms in our sample report less early stageinvestments than found in the EVCA statistics can be explained by the fact that EVCAstatistics report the stage distribution of new investments in 1995, whereas our samplereports the stage distribution of the current investment portfolio. This might thus in-clude investments venture capital firms entered at the early stage of development, butwhich have matured and are now reported as an expansion/development investment.

The US survey was carried out in late 1996. The US questionnaire was sent to arandom sample of 299 US venture capitalists listed in Pratt’s Guide to Venture CapitalSources. Follow-up reminders were sent after two months. A total of 73 completedand usable replies were received, representing a response rate of 24%. No significantdifferences were identified between respondents and non-respondents in terms of typeof venture capitalist and amount of capital under management.

Multicountry studies are fraught with potential problems relating to the captureof data from respondents. It is recognised that in some environments, there may beresistance or logistical problems relating to particular approaches. Hence, for example,Hitt et al. (2000) note in their study of foreign partner selection in developed andemerging markets that there was some resistance to mail questionnaires in some of theirsample countries and that they therefore used face to face interviews in order to obtainacceptable responses rates. We adopt this approach as we were concerned that in theAsian countries in our study, mail questionnaires could be problematical where there isa strong tradition of business secrecy. In India, Hong Kong and Singapore, therefore,attempts were made to conduct face-to-face or telephone interviews where possible inorder to maximise the response rate. Personal interviews were also expected to helpwith comprehension and in the event respondents had no problems comprehendingthe questionnaire. The same survey instrument was administered as in the US andEuropean countries.

The India survey was conducted during summer 1999. In Singapore and Hong Kong,the study was conducted in summer 2000. We contacted members of the venture capitalassociations in each country. We received a total of 81 responses, giving are responserate for Asia of 47.4%.

Ideally, it would be appropriate to collect data simultaneously. However, when thestudy commenced, several of the markets were quite under-developed and it wouldnot have been possible to conduct surveys there. The different actual real time periodsduring which data were collected may serve to capture markets at closer points in theirdevelopment stage. In more developed markets such as the US and UK, methods maybe more likely to be stable so it is less important to conduct surveys simultaneously.This issue is more important for developing markets, where we have achieved a closerdegree of simultaneity.

Results and analysis

Initial background analysis is provided of the similarities and differences between ven-ture capital firms operating in each of the countries using Kruskal-Wallis tests. As

316 WRIGHT ET AL.

a non-parametric test this is more conservative than parametric tests. The data weredemeaned on a firm by firm basis in order to address potential problems arising fromsystematic differences in the use of scales. Multivariate tests were carried out using OLSregression.

Univariate analysis

Valuation methods (see Table 2): Significant differences were identified between legalsystems and geographical areas in respect of several valuation methods. Asset basedvaluation methods were generally the least important valuation methods. We find sig-nificant differences between the legal systems (Panel A) in respect of the use of historiccost book values, with this being relatively important in countries with a French legalsystem. Elsewhere the scores are generally low in Europe, the US and Asia. The DCFmethod is significantly more important in Germanic countries, followed by Englishlegal system countries. There is widespread use of comparator rule of thumb approx-imations, with greatest importance attached to price/earnings multiples in Englishlegal system countries. With respect to geographic region (Panel B), historic cost as-set methods are significantly more important in Continental Europe than elsewhere.There was no significant difference between regions in the use of DCF techniques butprice-earnings multiples were most important in Asian countries followed by US andUK, ahead of Continental Europe.

Sources of information (see Table 3): Business plan data are rated highly in all mar-kets, but there was no significant difference in the importance of this informationsource between legal system (Panel A). Significantly more emphasis is placed on in-formation from entrepreneurs in Germanic legal system countries, ahead of France,with English legal systems expressing least importance. The financial press is relativelyless important generally, but significantly greater emphasis is placed on it in Englishlegal system countries. With respect to geographic area, significantly less emphasis isplaced on information from entrepreneurs in Asia, with greatest importance attachedto the entrepreneur in Europe, followed by US and UK. Greatest importance is at-tached to the information in the business plan in Europe, followed by the US andUK, with Asia having lowest importance. Relatively more importance is attached toinformation from the financial press in Asia, followed by the US and UK ahead ofEurope.

Multivariate analysis

Multivariate analysis was conducted to examine the effects of the state of developmentof external capital markets, the nature of the legal system and other institutional dif-ferences with the US as measured by Europe and Asia dummy variables. Combiningindividual countries in this manner also reduces potential problems arising from smallsamples in individual countries. Categorization of countries into different legal sys-tems was based on La Porta et al. (1997, 1998). The regressions also controlled for the


Table 2. Methods used in valuing potential investments.

Legal system N Mean Std. dev. Chi square

Panel A: By legal systemHistoric cost book value English 213 −.9154 .8856 47.88***

German 47 −.9333 .6781French 70 .2243 1.2005Total 330 −.6762 1.0445

Liquidation value of English 213 −.9379 .9163 .67asset (forced sale) German 47 −1.0184 .9010

French 70 −1.0186 .8254Total 330 −.9665 .8938

Discounted future English 214 .3697 1.0227 19.43***cash flow German 49 .9721 1.0611

French 70 −7.5714E-02 1.3393Total 333 .3647 1.1410

P/E basis English 212 .8105 .8265 8.18*German 47 .6199 .9283French 70 .4957 .9338Total 329 .7163 .8724

Panel B: By geographic regionRegion N Mean Std. dev. Chi square

Historic cost book value US and UK 137 −.9119 .8762 24.28***Cont Europe 117 −.2407 1.1681Asia 76 −.9217 .9081Total 330 −.6762 1.0445

Liquidation value of US and UK 138 −.8430 .9675 3.35asset (forced sale) Cont Europe 117 −1.0185 .8528

Asia 75 −1.1127 .7904Total 330 −.9665 .8938

Discounted future US and UK 138 .2874 1.0455 1.42cash flow Cont Europe 119 .3557 1.3323

Asia 76 .5191 .9689Total 333 .3647 1.1410

P/E basis US and UK 138 .7729 .8787 9.14**Cont Europe 117 .5456 .9296Asia 74 .8804 .7194Total 329 .7163 .8724

All tests are Kruskal-Wallis tests. Significance levels: ∗∗∗ p < .001; ∗∗ p < .010; ∗ p < .050; # p < .100.Note: Scale measures what valuation methods are applied ruing the valuation process to value poten-tial investments. Different methods were rated on a scale of: 5 = Almost always, 3 = Sometimes, 1= Never. Data has then been de-meaned for all venture capital companies—on an individual companybasis.

potential effects of investment stage, ownership type of venture capital firm (whetherthe firm was independent or captive) and years of experience in the venture capitalmarket as these were seen in Table 1 to vary between countries. We also controlled forthe state of development of the capital market based on La Porta et al. (1997).

318 WRIGHT ET AL.

Table 3. Sources of information in preparing valuations.

Legal system N Mean Std. dev. Chi square

Panel A : By legal systemFinancial press English 219 −.7152 1.0824 11.86**

German 53 −1.0539 .6872French 68 −1.1570 .7691Total 340 −.8564 .9899

Interviews with English 218 .3503 .8750 23.89***entrepreneurs German 53 .9272 .4688

French 70 .5230 .7505Total 341 .4754 .8240Total 341 −1.1419 .8831

Business plan data English 207 .5514 .8083 3.40German 52 .6731 .6661French 68 .7652 .6183Total 327 .6152 .7541

Panel B: By geographic regionRegion N Mean Std. dev. Chi square

Financial press US and UK 139 −.8395 1.1844 23.93***Cont Europe 121 −1.1119 .7332Asia 80 −.4992 .8415Total 340 −.8564 .9899

Interviews with US and UK 138 .5167 .9273 38.35***entrepreneurs Cont Europe 123 .6972 .6728

Asia 80 6.328E-02 .6929Total 341 .4754 .8240

Business plan data US and UK 127 .6935 .8603 18.34***Cont Europe 120 .7253 .6384Asia 80 .3258 .6628Total 327 .6152 .7541

All tests are Kruskal-Wallis tests. Significance levels: ∗∗∗ p < .001; ∗∗ p < .010; ∗ p < .050; # p < .100.Scale measures the importance of different sources of information in preparing valuations. Different sourcesof information were rated on a scale of: 5 = Essential, 3 = Moderately important, 1 = Irrelevant. Data hasthen been de-meaned for all venture capital companies—on an individual company basis.

Valuation Methods (see Table 4): Years of experience in the venture capital industry,ownership type of VC, number of investment executives and whether the firm is involvedin MBOs/MBIs generally have no significant impact on the importance placed onparticular valuation methods, except for a weakly signficant positive association of theage variable with the PE method. Early stage investments were weakly significantlypositively associated with use of liquidation value and weakly significantly associatedwith use of the DCF valuation method, while early stage investments were significantlynegatively associated with historic cost values of assets.

Different legal systems are significantly associated with the valuation mechanismused. VC firms operating in a French legal system are significantly more likely to adopthistoric cost valuation methods, thus providing limited support for Proposition P1a.


Table 4. Methods used in valuing potential investments.

Asset value Liquidation asset DCF P/EBeta (S.E.) value Beta (S.E.) Beta (S.E.) Beta (S.E.)

German legal system −.052 .318 1.311 −.756(.317) (.283) (.365)∗∗∗ (.290)∗∗∗

French legal system 1.028 .367 .121 −.855(.259)∗∗∗ (.231) (.300) (.237)∗∗∗

Europe .266 −.686 −.629 .789(.216) (.192)∗∗∗ (.250)∗ (.196)∗∗∗

Asia .095 −.724 −.185 .605(.210) (.188)∗∗∗ (.243) (.193)∗∗

External capital per GNP .100 .272 .337 −.395(.281) (.253) (.326) (.261)

Early stage −.066 .202 −.247 −.015(.120) (.106) # (.139)# (.109)

MBO/MBI .002 −.005 .007 .014(.010) (.009) (.011) (.009)

Independent −1.35 .002 .053 .070(.118) (.105) (.136) (.107)

Age .000 −.004 −.005 .010(.007) (.006) (.008) (.006)#

Investment executives −.001 .003 −.002 −.001(.000) (.003) (.005) (.004)

Constant −1.032 −.723 .586 .561(.271)∗∗∗ (.241)∗∗ (.313) # (.247)∗

N 287 287 290 286R2 .214 .107 .116 .097Adj R2 .185 .075 .084 .064F Stat 7.535∗∗∗ 3.335∗∗∗ 3.657∗∗∗ 2.963∗∗∗

Sources of information measured on a 1–5 likert scale. Data has then been de-meaned for all venturecapital companies—on an individual company basis.Legal system dummies coded - 1 = Yes, 0 = No.Regional dummies coded 1 = Yes, 0 = No.Stage involvement dummies coded 1 = Involved in stage, 0 Not involved in stage.Independent dummy coded as 1 = Independent (in some way), 0 = Fully dependent.Age is the number of years since the start of the firm.Investment executives is the number of executives employed in a country.Significance levels: #< .1; ∗< .05; ∗∗< .01; ∗∗∗< .001.

VC firms in Europe and Asia are significantly less likely than US VC firms to make useof liquidation value methods, thus providing support for Proposition P1b. Comparedto English-based Common Law systems, VC firms operating in Germanic and Frenchlegal systems are significantly less likely to use PE comparators (supporting PropositionP1d).

Sources of information (see Table 5): The number of years of experience in the venturecapital industry and whether the firm is involved in MBOs/MBIs have no significant im-pact on the importance placed on particular sources of information. VC firms operating

320 WRIGHT ET AL.

Table 5. Sources of information.

Interviews with entrepreneurs Business plan data Financial pressBeta (S.E.) Beta (S.E.) Beta (S.E.)

German .779 −.047 −.494legal system (.247)∗∗ (.239) (.291) #

French .276 .126 −.692legal system (.204) (.197) (.241)∗∗

Europe −.241 −.030 .704(.175) (.174) (.205)∗∗∗

Asia −.387 −.452 .574(.168)∗ (.167)∗∗ (.196)∗∗

External capital .049 .030 .175per GNP Early (.215) (.208) (.254)stage .003 .043 −.119

(.098) (.095) (.115)MBO/MBI .008 .000 −.004

(.008) (.008) (.009)Independent .114 −.076 −.144

(.095) (.092) (.112)Age .010 .000 .005

(.005)# (.005) (.006)Investment −.005 .003 −.002

executives (.003) (.003) (.004)Constant .342 .698 −1.240

(.214) (.211)∗∗∗ (.229)∗∗∗N 299 290 299R2 .150 .071 .145Adj R2 .121 .038 .115F Stat 5.108∗∗∗ 2.153* 4.885∗∗∗

Sources of information measured on a 1–5 likert scale. Data has then been de-meaned for all venturecapital companies.Legal system dummies coded—1 = Yes, 0 = No.Regional dummies coded 1 = Yes, 0 = No.Stage involvement dummies coded 1 = Involved in stage, 0 Not involved in stage.Independent dummy coded as 1 = Independent (in some way), 0 = Fully dependent.Age is the number of years since the start of the firm.Investment executives is the number of executives employed in a country.Significance levels: #< .1; ∗< .05; ∗∗< .01; ∗∗∗< .001.

under a Germanic legal system are significantly more likely to use interviews with en-trepreneurs but this is not the case for VC firms operating under a French legal system.There is thus mixed support for Proposition P2a. VC firms in Asia are significantly lesslikely to make use of interviews with entrepreneurs or business plan data, providingsupport for Propositions P2b and P2c. VC firms operating in a German or Frenchlegal systems are significantly less likely to place emphasis on the financial press. Thisprovides limited support for Proposition P2d. VC firms in Europe and Asia are sig-nificantly more likely than US VC firms to use financial press, thus providing somesupport for Proposition P2e.


Discussion and conclusions

This paper has presented an exploratory analysis of the valuation methods and infor-mation sources used by venture capital firms in different institutional environments.The findings presented here add to the limited data on the internationalization activityof venture capitalists. Hall and Tu (2003) suggest that the willingness of venture capi-tal firms to invest overseas is positively related to the size of venture capital firm andthe investment stage of their investees and negatively to the age of the venture capitalfirm and not related to the type of firm ownership. In contrast, our study exploresventure capital firm behavior and adds to the emerging debate regarding the influenceof different institutional contexts on firm behavior. The findings of the study presentnovel insights that are pertinent to the growing internationalisation of venture capital.We have identified significant differences in the valuation methods adopted by venturecapital firms in countries with different institutional contexts as well as the sources ofinformation they use. The findings are summarised in Table 6. Overall, a key theme isthat it appears that the legal system, and its implication for capital markets, may bemore important in explaining the source of information used than it is for the valuationmethods used.

However, cultural factors are found to play an important role in the relative impor-tance that is placed on information provided by entrepreneurs and in the business plan,and in the extent to which alternative external sources are sought. This suggests thatinformation sources are not so easily passed from one context to another. The actualsources of information that venture capital firms may trust vary both between andwithin legal systems and geographic regions. These findings indicate that apparentlysimilar systems and markets may in fact be heterogeneous. Further analysis might use-fully explore the rationale for such differences. In this paper, partly because of relativelysmall sample si7s in some countries, we have focused on geographical regions. It mightbe fruitful for future research to examine individual countries in more depth, althoughsuch analysis may need to await the further development of individual capital markets.

Table 6. Summary of hypotheses and results.

Hypothesis Prediction Result

Valuation methodsP1a (Asset valuation) French, German > English Limited supportP1b (Liquidation asset) Europe, Asia < US SupportedP1c (DCF) English > French, German Not supportedP1d (PE Comparator) French, German < English Supported

Information sourcesP2a. (Entrepreneur) French, German > English Mixed supportP2b. (Entrepreneur) Asia < US SupportedP2c. (Business plan) Asia < US SupportedP2d (Other information—financial press) French, German < English SupportedP2e. (Other information—financial press) Europe, Asia > US Supported

322 WRIGHT ET AL.

In relation to the control variables examined in this study, it is interesting that neitherthe stage focus, nor the affiliation of the venture capitalist (i.e. independent or not) weresignificantly related to the valuation methods or sources of information used. This isinteresting in the light of earlier research from the UK that did identify differencesbetween both information usage as well as valuation method and the affiliation of theventure capital firm (Wright and Robbie, 1996). While venture capitalists may seek toaddress information and valuation problems by investing in later stage transactionswith more established businesses, this does not appear to be the case across differentinstitutional environments. These findings suggest that regulatory and cultural insti-tutional factors may be more important than the focus of investment attention andownership of the venture capital firm. The state of development of a country’s externalcapital market was also not significantly related to the valuation methods or sourcesof information used.

Institutional contexts may not necessarily be static, especially in emerging markets(Hoskisson et al., 2000; Peng, 2003). The recent emergence of venture capital and privateequity markets in contexts where they have long been dormant is itself a reflection ofchanging institutional factors (Wright et al., 1992, 2003, 2004). Longitudinal studieswould help in identifying the links between institutional developments and changes inventure capital firm behavior. A feature of such developments may be that institutionaldifferences become less important over time and that agency and other factors maybecome more important. However, differences between institutional environments arelikely to persist such that there may be a need to develop research that considers theinteraction of institutional and agency perspectives. Hoskisson et al. (2000) speculatedin their examination of strategy in emerging markets that institutional factors wouldbecome less important over time. It is clear, however, that institutional differencesmay take longer to reduce than might be anticipated. Moreover, the pace at whichinstitutions change may also be different. There is, therefore, a need for researchers tocontinue to develop an institutional perspective on the venture capital industry.

This paper has a number of limitations and hence the findings need to be consideredtentative. These limitations also suggest areas for further research. First, the surveyswere conducted at different points in time. This may lead to potential issues of compa-rability if institutional environments change over time. However, offsetting this issuethe different points of real time do provide for some reduction in the gap between thestage of development of each market. Second, the study has been based on quantita-tive survey data. More fine-grained analysis concerning the process by which venturecapital firms search for information and undertake valuation might usefully be un-dertaken with the use of detailed case study approaches. Third, the study has reliedon attitudinal data. More detailed analysis might also be carried out using archivaldata on valuation and information sources. However, obtaining such data is highlysensitive, especially across different country contexts. Again, this may be an area wheredetailed cross-country case comparisons may be more feasible. Fourth, our analysisis very much cross-sectional. To the extent that venture capital markets are dynamic,there is a need of future research to consider the impact of learning and the diffusion ofpractices across markets in different institutional environments. For example, to what


extent do valuation methods become more sophisticated over the development of aparticular market and hence to what extent does convergence of practice occur? Fifth,the study has limited itself to considering only aspects of the venture capital process re-lating to valuation and sources of information for valuation. Other important aspectsof the venture capital life cycle may be important to consider in cross-country con-texts. For example, different approaches to monitoring and exiting investments may beappropriate in different contexts (Bruton et al., 2004). The relative importance of con-tracts versus relationships may differ between institutional contexts depending on thestrength of importance of the legal framework and the importance of social networks.The feasibility of different exit routes may vary between legal systems most obviouslywith respect to the availability of stock markets. However, sales to strategic partners aretypically the most common form of exit, yet a number of issues are raised about thisoption in different contexts. Not only do acquisitions markets vary in terms of theirstage of development but there may be different attitudes with respect to the sale ofmajority versus minority stakes, there may be different regulations regarding sales toforeigners, etc. Cumming and Fleming (2003) show for the Asia-Pacific region that ahigh legality index is associated with a greater likelihood of exit through IPO or tradesale but that a high legality index is neither necessary nor sufficient for the developmentof a successful venture capital market. Further research might usefully examine theseissues in different institutional contexts.

For practitioners, the findings of the study highlight the need for venture capitalfirms entering new markets to examine carefully within-regional differences. These dif-ferences are important for the success of venture capital firm entry into foreign marketsand the avoidance of exit in the face of failure. While it may be relatively straightforwardfor venture capital firms to use standard valuation methods, a major issue relates tothe informational inputs into those techniques. This in turn raises implications for therecruitment and training of venture capital executives, especially in developing markets.In terms of recruitment there may need to be particular emphasis on hiring executiveswho are experienced in obtaining deal specific information in a particular local context,which is likely to involve them having highly developed networks. Evidence on theserecruitment practices is patchy, but a study of German venture capitalists suggests thatgreatest emphasis is placed in the temporary transfer of executives from the head officesof foreign entrants, followed by the recruitment of experienced foreign nationals and therecruitment of foreign nationals to head up foreign operations (Hommel and Wright,2004). Evidence from India also indicates a high level of local national representationamong executives even in foreign venture capital firms (Wright et al., 2002). Firms inIndia were also found to recruit mainly executives who were already trained. If theseexecutives are mainly trained in US methods (Bruton and Ahlstrom, 2003), these maynot easily carry over into different institutional contexts, especially with respect to thegathering of information. While venture capital firms may implement firm-wide poli-cies regarding various aspects of their investment behavior, these observations suggestthe need to allow local offices a significant measure of discretion in their screening andvaluation of businesses. Evidence from Germany indicates that greatest discretion tolocal offices is given with respect to screening, followed by monitoring and, somewhat

324 WRIGHT ET AL.

less to valuation methods (Hommel and Wright, 2004). Further research might use-fully examine whether different institutional contexts influence local recruitment anddiscretion.

Overall, these observations also suggest that venture capitalists entering new marketsin legal and geographical contexts with which they are less familiar, may need to takea longer perspective to become familiar with local information sources and networks,otherwise they may run serious risks of investing on the basis of very inadequateinformation. The authors have obtained extensive anecdotal evidence from venturecapitalists new to foreign markets of being presented with business plans ‘thick withdust’. A key test is to find independent reliable sources of information to avoid theproblems in investing in such cases. Finally, our study also has implications for policymakers internationally. Efforts to develop and enforce harmonization of regulatoryenvironments may play an important indirect role in spreading good reporting practicesthat can assist the internationalisation of venture capital both in terms of improvingthe information available to venture capitalists when they screen and value businessesas consider here, as well as subsequent monitoring of performance. A further issueaffecting the availability of information concerns the implications of the general stateof development of entrepreneurship and importance of social networks in a particularcountry. While there is some debate about measuring entrepreneurship in differentcountries, it appears that its extent does vary considerably internationally (Reynoldset al., 2000). Similarly, the importance and nature of social networks also varies betweencountries and regions (Claessens et al., 2000). Weak legal systems or legal systems thatdo not promote disclosure relating to private firms present problems for venture capitalfirms access to information in environments where perception of entrepreneurs is lowand entry to social networks is difficult.

Acknowledgments

Thanks to the editor and two anonymous for comments on an earlier version.

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Documents

Venture Capital Investors, Capital Markets, Valuation and Information: US, Europe and Asia